Under Investigation, and Doing the Investigation

Whenever there is a report of corporate misconduct, a predictable response is that the company in question says it has hired a reputable law firm to conduct a thorough investigation, and it pledges to cooperate with the authorities to resolve the situation quickly.

Prosecutors usually announce their own investigation, if they say anything at all. In reality, the government often uses reports provided by the companies to decide how to resolve the case.

Yet this raises significant questions about conflicts of interest. Is it a good thing that much of the effort to police corporate misconduct seems to have been shifted to lawyers retained by the companies under investigation?

Companies would prefer not to conduct an investigation at all. But having a law firm they hired overseeing the inquiry means they can maintain control over information, and minimize any surprises.

For the legal profession, conducting corporate investigations is a growth industry. Louis J. Freeh, the former F.B.I. director whose work includes an extensive report on the sex abuse scandal at Penn State, recently agreed to merge his firm into Pepper Hamilton — a sign that large firms want the cachet of a big name to attract more business.

For the government, waiting until the company’s investigation is complete means there is no significant commitment of taxpayer resources on a case that may not result in prosecution. And there are good reasons to defer to the company’s lawyers, at least at the early stages of a case.

If a company’s overseas conduct is at issue, government investigators must slog through numerous bureaucratic steps to gather evidence. Private lawyers do not have to follow the same rules, so they can often gather information more quickly.

Employees may be more forthcoming with the company’s representatives, whether out of a sense of loyalty or the misconception that they are not at risk for prosecution. Even if employees are told that information may be turned over to the government, there can be a sense of comfort from being a team player, regardless of whether the details implicate them.

Lawyers from outside firms also often gain a better understanding of a company’s culture and operations. In-house counsel can point out where to look for information and explain how decisions were made. That kind of inside knowledge usually would not be available to prosecutors because it could expose confidential information.

It may seem as if having a law firm oversee the investigation of corporate misconduct benefits both the prosecutors and the company in the inquiry. But there is a risk prosecutors may not be getting a picture of all wrongdoing, and the potential for the report to be slanted in a way to protect senior management.

The lawyers who conduct investigations are often former prosecutors or regulators themselves, sometimes coming back to negotiate with their old offices on behalf of new clients. This can create an interesting twist on the so-called revolving door, when lawyers leave private practice temporarily to take government jobs. Some have said that such lawyers may be more lenient on the companies they investigate in the hopes of getting a job later on.

Robert Khuzami, the enforcement director at the Securities and Exchange Commission, disputed that view, saying recently that staff lawyers “would not risk reputation and career and even jail by undermining an investigation for a possible future job prospect.”

The real problem, in my opinion, with the revolving door may be that former government lawyers are trusted because they developed reputations as tough prosecutors and regulators. Companies can use that reputation to their benefit when the lawyers return to their former offices to represent them.

In practice, the lawyers employed to conduct corporate investigations must draw conclusions about conduct that falls into gray areas. Unlike murder and robbery, white-collar violations are difficult to identify and often call for nuanced judgments about intent and knowledge.

When lawyers report their conclusions, are they free from bias about the company that is also paying their bills?

Certainly, questions have been raised about the value of such reports. Since the financial crisis hit, few senior managers have been identified as among those responsible for a violation.

Prosecutors relying on law firms to do the legwork for an investigation and report on potential violations may not be in a position to challenge their conclusions by conducting an independent inquiry. The Justice Department simply does not have the resources to investigate a company to the same degree as outside lawyers operating with seemingly unlimited resources.

One solution is to expand whistle-blower programs to reward those who report corporate violations directly to the government. The Internal Revenue Servicerecently awarded $104 million to a whistle-blower who provided information that helped bring down the wall of secrecy around Swiss banks.

Whistle-blowers offer a glimpse into a company that would not otherwise be available. The potential threat of a whistle-blower also can give prosecutors and regulators more leverage because information is no longer controlled by the lawyers who oversaw an investigation. As every investigator knows, it is far better to keep the target guessing about exactly what you know.

Companies do not care for whistle-blowing programs because they divert information from their internal compliance systems and instead give it directly to the government, meaning it is not filtered first by outside counsel. Maybe that is not such a bad idea.

A version of this article appears in print on 09/25/2012, on page F10 of the NewYork edition with the headline: Under Investigation, and Doing the Investigation.